Government Borrowing: Insurance

House of Lords written question – answered on 11th March 2009.

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Photo of Lord Northbrook Lord Northbrook Conservative

To ask Her Majesty's Government what is the cost of insuring against the United Kingdom defaulting on its government debt compared with the cost in France or Germany.

Photo of Lord Myners Lord Myners Parliamentary Secretary, HM Treasury

There are no precise indicators of the cost of insuring government debt against default.

Credit default swap (CDS) spreads are commonly used as a proxy for measuring this cost. However, the strength of this proxy is highly questionable, as default is only one of a number of credit events enshrined in sovereign CDS contracts. Other credit events include missing coupon payments and restructuring of debt.

There are also a number of other factors besides market expectations of sovereign default risk that can affect CDS spreads. The market for developed country sovereign CDS is relatively small and illiquid, as it is unlikely that a developed country will default on its sovereign debt. The illiquid nature of the market can lead to large movements in CDS spreads, simply for technical reasons. In addition, there is evidence that developed sovereign CDS contracts are used to hedge a number of other risks, aside from the risk of sovereign default.

The five-year UK sovereign credit default swap spread was quoted at 147 basis points as of Friday 27 February 2009, according to data provided by Bloomberg. This compares to 89 and 86 basis points for France and Germany respectively. This implies that it would cost $14,700 to buy protection for $1,000,000-worth of gilts. It should be noted that we have no evidence that any trades have taken place at these indicative prices.

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